Magazine article Public Finance

Austerity Alternatives

Magazine article Public Finance

Austerity Alternatives

Article excerpt

THE FALTERING ATTEMPTS of the eillOZOlie countries to slash their dehts and deficits have led to an increasingly desperate search for an 'ideal· approach to austerity - one that will balance budgets but not cause long-term economic damageChampions of fiscal prudence have seized on the Baltic nations - Estonia and Latvia in particular - as examples of how this can be achieved. But there are plenty who would argue against those perceived successes and indeed against the need for austerity at all.

Last year, there were signs that the eye-watering spending cuts and tax increases being introduced in crisis-hit countries were beginning to reap rewards in terms of deficit reduction. But at the same time, economies continue to either flatline or shrink and unemployment has soared, with more than one in four people out of work in both Greece and Spain. And debt levels are still rising, with Greece's borrowing, for example, forecast to reach 189% of gross domestic product this year.

Contrast those figures with Estonia's recent performance and it's easy to see why the Baltic nation with a population of just 1.3 million has become the darling of the 'austerians'. After years of consistent economic growth, Estonia hit a brick wall in 2008 when a domestic slowdown was exacerbated by the global economic crisis. This led to a slump in consumption and investment and a fall in tax revenues. In 2009, GDP shrank by 14,1%. The International Monetary Fund forecast that, without action, the Estonian budget deficit would reach 10% of GDP in 2009.

Fast-forward to 2013 and the country is forecasting a budget deficit of 0.7% of GDP and economic growth of 3%, while its unemployment rate has steadily fallen since April 2010.

Jürgen Ligi took the helm as Estonia's finance minister in June 2009 when the country's recession was at its peak. He embarked on a large-scale austerity programme, cutting overall spending by 10% between 2008 and 2010, and increasing tax, including putting up VAT from 18% to 20%. Estonia's response to the crisis was 'to make quick decisions and not to rely on fiscal stimulus', he tells Public Finance.

'I wouldn't call it austerity, it was control of expenditure and also structural reforms for future growth.' he explains. Two-thirds of the consolidation came from spending' cuts, including reducing operational government costs such ;is wages. Ministers also embarked on longer-term changes aimed at making Estonia's labour market more flexible and controlling health care costs.

Unsurprisingly, these measures hurt - output fell dramatically and unemployment soared to 19% in April 2010 - but Estonia saw little of the scenes of popular discontent that have characterised the Greek and Spanish responses to austerity. Ligi ascribes this to the Estonian people's understanding that the country's 'unrealistic' boom had to be corrected. The country also had the incentive of prospective membership of the euro to encourage it to keep its budget deficits below the 3% of GDP required to join the single currency.

'We had the momentum, society was ready to adjust - and also the symbol of the euro helped us." Ligi explains.

Estonia's problems and the responses to them have much in common with events in neighbouring Latvia, perhaps unsurprisingly given their shared recent histories - first as part of the Soviet Union and then as new members of the EU.

In Latvia, years (if economic growth were followed by an abrupt crash, with GDP falling by 17.7% in 2009 alone. In the same year, a previously minimal budget deficit reached 10.1% of GDP. The situation worsened so much that the country had to be given a euro7.5bn bailout from bodies including the European Union and International Monetary Fund. Following a similar path to Estonia, the Latvian government then embarked on a front-loaded package of austerity measures, weighted two-thirds towards spending cuts and one-third towards revenue increases.

The effect, it seems, was dramatic. …

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